An electronic trading system provides a central market place where both buyers and sellers (often referred to as traders or market participants) can buy/sell financial instruments. Traders connect to the electronic trading system via their own trading computers, which can receive market data from the electronic trading system, and which can issue commands to buy or sell specific financial instruments. The issuance of commands to buy or sell financial instruments from a trading computer to the electronic trading system is called electronic trading (or in this application, simply trading). Because the function of electronic trading systems is to facilitate the market for various financial instruments, the electronic trading systems are sometimes called electronic markets or electronic exchanges.
Agency brokers are entities that can issue orders to trade to the electronic trading system on the behalf of other parties. Traders may be required to hold a specific permit before being allowed to act as agency brokers with an electronic trading system. For example, traders must possess an Amex Trading Permit (ATP) in order to act as agency brokers with the New York Stock Exchange (NYSE) Amex options trading platform—for this reason agency brokers are also called ATP Holders in the context of the Amex options trading platform.
Electronic trading systems support a number of common order types that can be submitted into the market. Two types of common orders are: limit orders and market orders (the latter also referred to as “at market” orders). A limit order is an order to buy or sell a set number of financial instruments at a pre-determined price or better. Better is a higher price when selling, and a lower price when buying. A market order is an order to buy/sell a set number of financial instruments at the prevailing market price until the specified quantity has been met or the order cancelled. A market order has no price at which to trade, rather just a quantity of lots. A market order is executed at whatever price is currently prevailing in the market.
When a market participant issues an order to an electronic trading system to sell a financial instrument, the electronic trading system will attempt to match the sell order with an existing buy order that has a price that satisfies the seller's price requirements. Similarly, when a market participant issues an order to buy a financial instrument, the electronic system will attempt to match the buy order with an existing sell order. If the order that is issued by a market participant is a limit order, but that order is not marketable (i.e., there is no matching counterparty order that meets the limit order's price requirements), then the limit order will be stored in an electronic order book. The electronic order book will store the unexecuted order according to the rules of the electronic exchange until a counterparty with a matching order can be found to execute the trade, or until the order is cancelled. The orders to buy that are stored in the order book are called bids, while the orders to sell are called offers. The difference between the highest bid on the order book and the lowest offer is called the bid-offer spread or buy-sell spread. Price information about bids and offers for equity option contracts in various electronic markets in the United States are tracked by the Options Price Reporting Agency (OPRA), OPRA maintains a database of the best bids and offers for each tracked option called the National Best Bids and Offers (NBBO) database.
Agency brokers may provide trading services for large volumes of customers, and may also trade for their own account, subject to the rules and regulations of the electronic markets and of the SEC. When a customer places an order to buy or sell equity options through an agency broker, the agency broker may have existing customer orders that can be matched against the order, or the agency broker may be able to act as a counterparty directly by trading for their own account. However, instead of directly executing such orders internally, an agency broker may be required, by rules or regulations, to place an order with an electronic exchange in case a third-party is willing to offer a better price for the customer's order than that offered internally by the agency broker. An electronic trading system may facilitate such orders by using an auction mechanism, where the customer order is made public, and offers from potential counterparties are received. An auction system is advantageous in that it opens up the customer order to price improvement from many different potential counterparties. However, a fixed-duration auction is open to abuse as potential counterparties have an incentive to wait till the auction is about to expire before revealing the price they are willing to pay in order to prevent competition from improving on their offers before expiration of time. Thus there is a need for a system that provides price improvement in the manner of a fixed-duration auction, but which is not open to exploitation as described.